A Brief History of Umbrella Companies

Umbrella Companies are not a new idea. Indeed they have been around for a number of years, but they came into their own after the 2007 budget and the subsequent "Tackling Managed Service Companies" legislation that came with it.

Before the 2007 budget umbrella companies could be mistaken as being a similar structure to either the old composite company or single person company structures, but the modern (post 2007) umbrella company when done correctly is a very different creature.

Legally umbrella companies now are much more complex than their predecessors and when set up properly they become a very tight and compliant way to be paid.

How do Umbrella Companies work?

Umbrella companies may best be described as PAYE with a twist. Through an umbrella company you can expect to pay full PAYE tax and national insurance but you will be able to claim back business expenses. Umbrella Companies do not have a dividend element like the old composite and single person companies. If they did they would immediately fall foul of the "Tackling Managed Service Companies" legislation.

What is the benefit to contractors?

Due to the necessary switch to full PAYE tax and NI the financial gain to contractors has reduced since the days of single person companies. The tightening of legislation has forced companies to focus on compliance more than ever before, and this brings with it an unavoidable cost.

The main advantage to contractors now is from what is known as an uplift. This is an increased rate for contractors employed by another company. A recruitment agency might offer a rate of £10 if a contractor wants to be paid PAYE through the agency themselves or £11 or more if the contractor opts to be paid via a limited company (because of the potential savings to them). With composite companies and single person companies the uplift was often present, but it was never the main advantage to the contractor, it was more the icing on the cake.

Using the 2009/10 tax figures if a contractor were to work 40 hours at £15 per hour, and claim £75 of expenses through an umbrella company they could expect to take home around £408 compared to an agency take home of £400. If the agency were to give an uplift of even £1 for using an umbrella company, this would increase the umbrella take home to around £433, whilst still saving their agency a significant amount in the process.

It doesn't all come directly down to money of course. When you work for a legitimate umbrella company, you are an employee and have all the statutory rights of an employee; statutory sick pay, maternity pay, paternity pay and all the rest.

Why are Umbrella Companies so popular?

The popularity and widespread adoption of umbrella companies is largely because they are the most compliant alternative to a PAYE payroll. The "Tackling Managed Service Companies" legislation made it clear that a PAYE umbrella company falls outside the definition of a Managed Service Company.

At face value this left umbrella companies free and clear but closer inspection has shown that an umbrella company can still be treated as a managed service company provider if for instance they do not operate with an overarching contract.

It's important to bear in mind that although umbrella companies may be the simplest structure to keep compliant, they are not simple in the way that composite companies or even single person companies were. The contracts and legal framework behind them is significant, essentially you are more likely to be working through a compliant structure with a larger established company.

You might also be interested in reading about Single Person Companies and Composite Companies.